Maybe it’s the fork-it-over times we live in: ATM fees, airline baggage fees, bombastic credit card late fees. Fees, fees, fees. At least there’s no fee to breathe. Yet.
The investment world isn’t immune to fees, either. So with increasing annoyance — coupled with fiscal prudence — investors are asking more than ever: Do we really need to pay all these fees to buy, sell and maintain holdings?
“This is an area that befuddles many investors,” says David Twibell, president of the Custom Portfolio Group in Englewood, Colorado. “Load fees, management fees, fee waivers, 12b-1 fees are all a confusing mess.” (The 12b-1 is a mutual fund’s annual marketing or distribution fee.)
Calls for more transparency. In the face of all the jargon and confusion, it’s no wonder fees have come under increasing scrutiny, even if the investing public isn’t quite sure what or how to scrutinize.
No one knows the turf quite like Steven Wallman, a former Securities and Exchange commissioner. Investors came to him with their gripes and he learned a lot by hearing them out.
“The industry’s structure of charging by the trade frequently encouraged bad investing,” says Wallman, founder and CEO of the Folio Investing online platform. “Not only does it result in brokers wanting to encourage lots of trades so they can make more money, but it means it’s actually hard for investors to take advantage of the one free lunch in investing, which is diversification.”
So with free lunches turning into fee lunches, Wallman has a core message that’s catching on: The investment world needs transparent fees. “Every dollar you pay in fees and trading commissions is money that will never go to work for you,” he says. “And the value of those lost dollars compounds over time.”
Here’s a measure of that impact: In a 2014 article in the Financial Analysts Journal, Vanguard Group founder John C. Bogle calculates that a 30-year-old retirement investor in an actively managed fund — with transaction costs and sales charges — would accumulate $561,000 after 40 years (assuming a 7 percent return).
That same investor opting for an index fund without those charges would collect $927,000. That’s an advantage of more than 65 percent — and enough to buy plenty of cruise ship tickets.
“Many clients don’t understand what they’re really paying for. As an example, investors think they are paying high fees for the manager,” says Preston McSwain, managing partner and founder of Boston-based Fiduciary Wealth Partners. “However, in reality they are often paying high fees for the broker-dealer business platform, marketing, sales management and commissions to brokers.”
What’s an investor to do? “Ask a lot of questions, especially about business models — how a firm makes money — and about what incentives drive your advisor’s compensation,” McSwain says. In other words, “Learn how your broker gets paid on various products and services.”
And from that advice stems a truth too many investors overlook: Fees are not inevitable. In fact, investors themselves incur many as they play the market in unproductive ways.
“Investors should not attempt to time the market,” says Bob Johnson, president and CEO of The American College of Financial Services in suburban Philadelphia. “While transactions fees have fallen dramatically in recent decades, fees can add up for do-it-yourself investors who constantly trade in and out of the market. DIY investors would be wise to heed the adage that time in the market is more important than timing the market.”
How to tell when fees are justified. Yet to some, it’s a case of when fees are justified versus when they’re not. Some of the debate surrounds whether an actively managed mutual fund can beat the passive index fund — and thus give grounds for the fees attached to it.
“As in everything else, paying fees for a ‘value added’ is not necessarily a bad thing, as long as you are getting value,” says Brian Menickella, founding partner of The Beacon Group of Companies, also based in suburban Philadelphia. “The real rub comes from the numerous studies that find only about 20 percent of the actively managed funds beat their correlated index, and rarely is it the same 20 percent.”
Others go a step further in their assessment. “If you mean fees for advice around investments, then yes, they are justified,” says John Anderson, head of practice management solutions at the SEI Advisor Network. “Many studies show that the average investor, left to their own devices and behavioral biases, doesn’t do a good job of investing for themselves.”
Anderson puts it this way: “There are always fees — and the sensible bottom line would be what the investor values, is willing to pay and how it fits into an overall plan or solution.”
Even commission-free exchange-traded funds aren’t immune. An October report by Pershing LLC cautions that fees can creep in via factors such as the bid-ask spread — that is, the price someone is willing to buy the ETF versus sell it. The wider the spread, in theory, the higher the fees.
“They are not a panacea,” says ReKeithen Miller, a portfolio manager with Palisades Hudson Financial Group in Atlanta. “The wider the spread for an ETF, the more it will cost you to buy or sell shares. ETFs that enjoy tighter bid-ask spreads typically have more liquidity and are easier to purchase and sell at a given time.”
Tips for reducing those pesky fees. For starters, no two financial institutions are alike. A September white paper by Personal Capital, “The Real Cost of Fees,” shows that of 11 brokerages selected, Merrill Lynch has the highest average total fees (1.98 percent), while the Texas-based brokerage USAA had the lowest (1.06 percent, or 87 percent lower).
Beyond this, “My rule of thumb is to skip any investments that charge a load or assess a 12b-1 fee–it simplifies things a lot,” Twibell says. “There are a lot of good mutual funds and exchange traded funds available that charge less than 0.7 percent, and many that charge less than 0.3 percent.”
He adds: “Put those on your shopping list.” After all, Black Friday doorbusters are just a few weeks away.
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Fees and Charges That Destroy Investors’ Portfolios originally appeared on usnews.com
